When to Refinance a Mortgage (And When to Stay with What You Have!)
Refinancing can be a useful tool to secure a loan that fits your needs. But it’s not for all homeowners at all times. There are specific situations when a refinance is appropriate; likewise, there are times when it may not be the right choice.
Understanding when to refinance, and when to stick with the loan you have, will make you a better homeowner.
Note: Article is General Information Only
This article is for general information only and is not financial or real estate advice. Always speak with an expert before making a decision on when to refinance your mortgage.
When to Refinance?
When You Have a High Interest Rate on the Mortgage
If you took out a mortgage years ago and, for whatever reason, you have a high interest rate on the loan, you may be able to refinance to a lower rate. Getting a lower rate can significantly reduce the cost of borrowing money. For example, if you have a $500,000 mortgage loan with a 5% interest rate, the monthly principal and interest payments would be $2,684. (According to our Mortgage Calculator.) However, if we were able to reduce the interest to 4%, the “P & I” drops to $2,387, a difference of $297 a month. Over the course of ten years, this brings a savings of $35,640!
When You Have a Short-Term Loan and are Struggling With Payments
Taking out a 15-year loan makes a lot of sense, as it allows you to pay off the loan at a faster pace while also paying much less in overall interest. After 15 years, you are free and clear, while someone with a 30-year loan is only halfway through.
But 15-year mortgages have higher payments. So if you are struggling with bills, you could refinance into a 30-year, giving yourself a little more wiggle room in the monthly budget.
The overall difference in monthly payments between a 15- and 30-year loan can be staggering. Using the example above ($500,000 loan, 30-year fixed, 4% interest), we have a payment of $2,387. However, if we keep everything the same but switch to 15-year, the payment is inflated to $3,698. This is a simplified example, but it shows the stark difference between 15- and 30-year loans.
When You Want to Pay Off the Loan Faster (and can Afford It)
On the other side of the topic, there is the fact that you can refinance to a shorter mortgage, such as going from a 30-year to a 15-year. With this strategy, you will have a larger monthly payment, but the loan will be paid off much faster. If you can afford it, this strategy allows you to be free of mortgage payments after only 180 monthly payments instead of 360. In total, 15-year mortgages cost less than 30-year, so it could be a wise long-term strategy.
When You Want to Convert an ARM Loan into a Fixed
Adjustable-rate mortgages can be useful options, as they come with an introductory period where the interest rate is fixed. Using this short period, you can own a home with relatively low payments. Then, once the introductory period is over, which is usually about five to ten years, you can refinance to a fixed-loan. For many reasons, including stability and predictability, many people prefer fixed-rate loans over ARM loans, so refinancing out of an ARM could be a wise choice.
When Your Credit Score Has Improved Significantly
This is directly related to the point about interest rates. If you took out the loan when you had a low credit score, you are likely paying a high rate on the mortgage. After a few years of making steady payments, it’s entirely possible that your credit has improve, which means you may be eligible for a lower interest rate.
When to Avoid Refinancing
If the Loan Will Be Paid Off Soon
Refinancing costs money. Just like taking out an original loan on your home purchase, there are fees and costs associated with processing the new loan. To recoup these costs, you need a significant amount of time. For example, if it will cost $5,000 to refinance, and the new loan will bring $200 in monthly savings, you would need 25 months, just over two years, to recoup the costs of refinancing. So if you only have a couple years or less on the loan, you may not want to refinance.
In many cases, it won’t make financial sense to refinance if you have less than five years on the loan, but you will need to crunch the numbers to see if the savings fit your specific situation.
If You Will Move in the Near Future
If you plan to move, or if there is a strong chance that you will move in the near future, you may want to hold off on refinancing. If you move, you will need a new mortgage loan anyhow, so you might as well wait to see where life takes you. After all, it would be a waste to spend thousands of dollars to refinance just to move in a new home, and take out a new mortgage, a few years (or months) later.
When Your Credit Score Has Plummeted
In general, if your credit score has gone down since you took out the mortgage loan, you will want to avoid refinancing. While you may be able to get a loan that fits your specific situation, if your credit has declined you will likely pay a higher rate. So even if you were to refinance to extend or shorten the loan terms, you may end up with a higher rate than you had before, which could negate any benefit.
When You Haven’t Done the Math
No matter what type of loan you have, how many payments you have left, or what interest rate you pay, if you haven’t done the math on your potential refinance, you should not move forward. We know that refinancing will cost money upfront, what you don’t know (at least not until we crunch the numbers) is whether it will save money on the long run. Once you do the math, you can make an informed choice on when to refinance a mortgage loan.
Reliable Support for Your Refinancing
Wondering if the time is right for your refinance? Contact our staff today and we’ll take an honest look at your situation to see if refinancing would be smart for your specific needs.